After failing to scuttle the landmark legislation in Congress, critics of the Dodd-Frank Act overhauling financial regulations are trying to chisel away at it in the courts — with some initial success.
Twice, federal regulators have lost in court trying to defend the rules, which were put in place after the 2008 financial crisis. On Friday, they were back in court again, fighting for yet another regulation they say is linked to Dodd-Frank.
Each time, the challenge came from a lawyer with a prominent legal pedigree: Eugene Scalia, son of Supreme Court Justice Antonin Scalia.
The legal battles raise an urgent question that’s likely to surface again and again about how much deference the courts are willing to grant the agencies that police corporate America.
“After all the lobbying in Congress to tear down Dodd-Frank, there’s now a second stage in the war: the courts,” said Donald Langevoort, a Georgetown Law securities professor. “The judges seem more than willing to say that the rules adopted in the aftermath of the financial crisis simply can’t be enforced because of procedural defects.”
In the case Friday, a federal judge heard a challenge to a rule that requires mutual funds that invest in certain financial instruments to register with the Commodity Futures Trading Commission. Last week, the same court struck down a regulation designed to rein in speculative commodities trading. And about a year ago, an appeals court blocked a rule that would have made it easier for shareholders to oust members of corporate boards.
In each case, Scalia’s team at Gibson, Dunn & Crutcher argued that the regulators failed to justify the rules they crafted or fully consider their economic impact.
“The agencies gave reasons that didn’t add up, contradicted themselves or failed to respond to significant criticisms raised by the public,” Scalia said in an interview. “Any one of those things is going to result in a rule getting thrown out by any court at any time.”
In the case argued Friday, the CFTC said that the financial overhaul bill gave it authority to set the new rules for mutual funds. But the plaintiffs said the rule is unrelated to the Dodd-Frank law, and that the agency is using that law “to change the subject” because the regulation is neither necessary nor justified by economic analysis.
Similar arguments prevailed in the two cases decided by the courts so far.
In the commodities trading decision last week, U.S. District Judge Robert L. Wilkins told the CFTC to justify the need for a regulation that would limit how many contracts a trader can obtain for the future delivery of 28 commodities, including natural gas and oil. The rule also would have applied to certain financial instruments known as swaps, a form of derivative.
The agency said it was acting under a Dodd-Frank mandate designed to reduce excessive speculation in the commodities market so that no one trader could control such a large percentage of the market that it skews prices.
Two Wall Street groups — the Securities Industry and Financial Markets Association and the International Swaps and Derivatives Association — said Congress did not mandate the caps, but rather asked the agency to determine if they were necessary and appropriate before imposing any. They sued, and Wilkins sided with the industry’s interpretation of the law.
“The CFTC’s error in this case was that it fundamentally misunderstood and failed to recognize the ambiguities in the statute,” wrote Wilkins, an Obama appointee. He kicked back the regulation to the CFTC for “further proceedings.”
In a statement, CFTC Chairman Gary Gensler said that establishing these limits is “critically important” and that the agency would consider its options.
The Securities and Exchange Commission has put off action on the regulation that would have made it easier for major shareholders to remove corporate board members and nominate new ones. In that case, a federal appeals court in the District of Columbia last year reprimanded the SEC for failing to adequately consider the economic consequences of the rule.
Some experts who tracked that decision said the ruling set an insurmountable hurdle for assessing the costs and benefits of a regulation — essentially asking the agency to calculate the cost of things that don’t have a strict dollar value or can’t be predicted.
By contrast, the cost to industry is more easily quantifiable, which means the court’s decision favors Wall Street interests, said Michael Greenberger, a former CFTC director.
“In the hands of conservative jurists, the benefits never exceed the costs,” said Greenberger, a professor at the University of Maryland law school. “It’s a game you can’t win.”
The ruling has cast a pall over administrative agencies, many of which are pressed for money and staff and running behind on congressionally mandated deadlines for finalizing regulations, Greenberg and other observers said. The SEC, for one, didn’t appeal the court’s ruling. Instead, it has redoubled its efforts and devoted more time to analyzing the costs and benefits of its rules, said Michael Conley, the SEC’s deputy general counsel.
That’s “slowed down the pace of regulation,” Conley said, “but we’re rising to the challenge.”
Generally, legal experts say, courts tend not to second-guess the expertise of an agency when it comes to crafting rules, especially highly technical ones, which is why some observers have been surprised by the rulings.
J. Robert Brown, a professor at the University of Denver law school, said agencies risk being overturned if they act in an arbitrary way. But in defining what is arbitrary, agencies get a lot of latitude.
“The courts have to ask: Does the agency have the authority to do what it’s doing?” Brown said. “Once it’s determined that they have the authority, the standard of review by the courts is supposed to be very deferential to the agencies.”
But Scalia said the SEC in particular has been tripped up repeatedly in court because of a 1996 law that imposed heightened responsibilities on the agency to consider how its rules affect “efficiency, competition and capital formation.”
It’s these considerations that helped him block an SEC regulation in the mid-2000s that would have required mutual fund boards to be led by chairmen independent of management, and another in 2009 that would have allowed the SEC to regulate a particular kind of annuity as a security.
“It’s not that the courts are suddenly applying heightened standards,” Scalia said. “The standards have been applied for years, and the errors committed by the agencies are errors that at any time before any panel of judges would have resulted in the rule being invalidated.”